Overrated

A good week for

• Oil gained c. +1.5% in US dollar terms
• The US dollar strengthened modestly on a trade weighted basis

A bad week for

• Equities softened, led lower by Europe (c.-1.6% in sterling terms)
• Bonds also declined, with US treasuries and UK gilts down c. -0.5% in local terms

UK monetary policy

The Bank of England (BoE) voted to raise interest rates again at its August meeting, taking the policy rate to 5.25%. In July, the Bank executed a double-sized 0.5% hike in response to the rapid rise in market-based indicators of inflation and interest rate expectations, along with stronger-than-expected growth and inflation data. But this month its guidance was more sanguine, with the policy statement focussing on how long rates needed to be restrictive for, rather than how much higher they needed to be. This likely signals that Monetary Policy Committee members expect rate hikes to be coming to an end. While interest rate expectations have cooled since their peak in July, they remain higher than at the time of the May report, when GDP and employment forecasts were revised dramatically higher. The higher expected path of rates has contributed to a downward revision in GDP forecasts, with growth now expected to be below 1% through to 2025, and inflation below the 2% target at the end of the forecast. Given that the government is likely to cut taxes ahead of the next general election, which could support spending, growth is likely to be somewhat stronger than this, which could support inflation also.

UK housing

June money and credit data pointed to an acceleration in the housing market, with mortgage approvals rising to an eight-month high. However, approvals remain below the pre-pandemic average and the June pick-up likely reflects the lagged effect of a lull in mortgage rates that happened in the late spring. Survey data from the Royal Institute of Chartered Surveyors points to weaker activity in July and beyond. This is echoed by July house price data from Nationwide, which saw prices down 0.2% month-on-month. The impact of interest rate rises is likely to be gradual, given the higher proportion of fixed-rate mortgages than in the past, with the effective mortgage rate on the outstanding stock still below 3%.

US borrowing

The credit quality of US government bonds was downgraded by ratings agency Fitch last week, on declining governance standards and weakening debt-to-GDP metrics. The downgrade saw the US’s rating fall to stable (AA+). S&P also rates the US government as stable, with Moody’s now the only AAA rating. Fitch cited for the downgrade a significant increase in government debt in the wake of the pandemic. 2020 saw debt grow to 115% of GDP, compared to 94% in 2019, and debt is expected to remain at around 110% through to 2024. Fitch argued that the “debt ceiling” mechanism, whereby additional borrowing must be negotiated on a bipartisan basis, added further risk to the sovereign’s rating, as defaults were possible if no agreement was found. The market response to the downgrade was sanguine, reflecting the fact that US treasuries remain a popular safe-haven asset and that its rating is still strong relative to peers.

US employment

July’s US payroll report was taken as a sign that the US Federal Reserve’s monetary medicine was taking effect. Non-farm payrolls were in line with expectations, rising by 187,000, and June’s print was revised lower to 185,000. Further evidence of softening was in hours worked, down from 34.4 hours/week to 34.3, a 0.2% decline in aggregate hours worked in July. The continued gradual deceleration in labour data is expected to allow the Fed to end monetary tightening, or at least to limit the pace of further rate hikes. Market pricing of rates reflects this, with negligible further hiking expected, and almost one percentage point of cuts anticipated by next summer.

Oil

Oil prices received a boost last week after Saudi Arabia opted to extend a voluntary production cut for another month. The reduction of one million barrels per day will run until September, with a further extension possible, as well as an enlargement. Russia will also cut exports by 300,000 barrels a day in September. This announcement comes as demand expectations are falling, given weaker global economic activity, with oil prices weakening as a result. However, given that many OPEC nations are struggling to lift output to quota levels, only countries with excess supply, such as Saudi Arabia, are able to impose cuts to support prices.

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